Guide to capital gains calculation

If you sell a property for Rs 50 lakh today that was purchased in 2000 for Rs 20 lakh, how much would be your capital gain? If your answer is Rs 30 lakh, you would only end up paying more taxes. Calculating capital gains is not a simple math but not difficult too either. In order to compute the capital gains we need to be aware of certain terminologies. Take a look at them.

Capital Assets

For computing capital gain there should be a transfer of capital asset. A capital asset includes property of any kind whether fixed or movable, tangible or non-tangible. However not every property constitute capital asset for calculation of tax. Certain assets like wearing apparel, furniture held for personal use or for use by the dependent relative is not considered capital asset for tax purpose. Similarly, agriculture land is also not considered capital asset and therefore selling the same doesn’t attract any tax liability on the person. The examples of capital asset that are considered for capital gain are gold, debt, equity and property.

Short term and long term capital asset

A capital asset is divided into short term and long term. The former is one which is held for duration of 3 years. A long term capital asset, on the other hand, is held for more than 3 years. However, there are exceptions to this rule. Equity, for instance, is considered as long term capital asset even if held for even a year. Same is the case with debentures and some mutual funds too. If the asset sold is a short term capital asset, the gain would be short term capital gain. But if the asset transferred is long term capital asset, then long term capital gain would arise.

Transfer of capital asset

For arriving at the capital gain figure, it is essential that the capital asset is transferred. The later simply means sale, exchange, relinquishment of the asset or extinguishment of the right of the asset. However, not all distribution is treated as transfer. For example, any gift made in kind is not treated as transfer. Similarly, distribution of family assets in kind at the time of partition is also not treated as transfer. But if an employee gifts the shares alloted to him from his employer to any other employee, it is treated as transfer for the purpose of capital gain calculation.

Cost of acquisition

This is simply the price at which the asset was acquired. However for calculating capital gain we take the indexed cost of acquisition. The later is the cost which is adjusted against the inflation. In simple jargon, indexation is the process that considers inflation from the time of buying the asset to the time of selling. As a result the purchase price of the asset gets increased and tax liability reduces. For this purpose, the Cost Inflation Index(CII) is used. It is an inflation index tool used to measure the rate of inflation in the economy. The value of the index is determined by the government and increased every year to reflect inflation. For year 1981-82 the CII is100, it is fixed at 939 for 2013-14. In order to calculate the indexed cost of acquisition you have to multiply the cost of acquisition with the cost inflation index value of the year in which sale is made and divide it by the cost inflation index value of the year of purchasing. The resultant figure would be indexed cost of acquisition. Suppose you want to sell a house for Rs 70 lakh. You acquired it for Rs 5 lakh in 1981. But if you indexed it, the purchase price comes to around 47 lakhs.

For the computation of capital gain it’s not just the cost of acquisition that matters. Any cost incurred on the improvement after acquiring the asset is clubbed along with it and indexed on the basis of cost inflation.

Computation of Capital gain

After knowing the constituents of the capital gain, it is easy to calculate the capital gain. The latter is simply the difference of the sale price over the indexed cost of acquisition and improvement. Since the indexed cost is higher, the difference would be higher too and consequently the tax liability will be lower.

Tax exemption on capital gains

While long term capital gain is fully exempted from tax in the case of equities, it is not true for all asset classes. In case of other asset tax on long term capital gains is around 20% with indexation and 10% without indexation. But the good news is that you can further save tax on your capital gain by following ways

Investment in residential property

In case you want to save capital gain accrued on you the sale of your residential house, you invest in residential property before one year of transfer or two years after transfer of your residential house. The amount invested or the capital gain whichever is lower would be exempted from tax under section 54 of the Income Tax Act. In case of sale of long term capital asset apart from house property, the capital gain can be protected by invested in a residential property either before 1 year or 2 year after the sale. Alternatively you can construct a residential house within 3 years from the date of transfer. However, at the time of sale of the asset, the tax payer should own only one residential property. The exemption amount would be calculated by multiplying the capital gain with the investment amount and dividing it by the sale price. This is as per section 54F.

Until now, investment made in property outside the country was also considered for exemption purpose. But the recent budget has done away with it and now only the investment made in the property in India only counts for exemption purpose.

Investment in bonds

Another area where you can invest to save tax on capital accrued on transfer of any long term capital asset is bonds. You can invest in bonds issued by National Highways Authority of India (NHAI) and Rural Electrification Corporation (REC). The maximum investment you can make is Rs 50 lakhs. However, the exemption will be to the tune of the investment amount or capital gain whichever is lower. In such a scenario, you have to purchase bonds within 6 months from the date of transfer of the asset under section 54EC.

Of late, government has brought amendments to the section. As per it, now the exemption is available in the investment of bonds only to the tune of Rs 5 0 lakh. This was done to curb the unhealthy practice of people of spreading investments across two financial years and claiming exemption for the same.